Big Jump In Junior Silver

Precious Metal mining ETFs – those that invest in the companies that explore and produce precious metals around the globe – had a very difficult year in 2013, writes Cinthia Murphy in this article, first published at Hard Asset Investor's sister site, ETF.com

Gold and silver miner ETFs bled more than half of their value as gold and silver prices sank. But so far this year, they've been delivering serious performance, particularly in the small-cap segment.

Funds like the Market Vectors Junior Gold Miners ETF (GDXJ) and the PureFunds ISE Junior Silver (Small Cap Miners/Explorers) (SILJ), for instance, have rallied now 20.7 and 29.5%, respectively, since the beginning of the year. That performance is outpacing the also-impressive gains in their larger-cap counterparts, the $7 billion Market Vectors Gold Miners ETF (GDX) and the $216 million Global X Silver Miners ETF (SIL), as in the chart below.

These are a significant jump in returns in a very short time, considering these same four funds gave up as much as 60% of their value last year when investors continued to shun the perceived safety of precious metals altogether for other equities and short-term debt securities.

That distaste for precious metals markets – and mining stocks – has been the case for much of the past 2.5 years, following the global economic crisis. To put it in CPM Group's words – a commodities research and consulting company that issued a research note earlier this month – "as investors realized the world was not ending, we expected them to bail out of precious metals. They did."

For instance, those investors who held on to GDXJ in the past three years or so have watched the fund slide nearly 70%. GDXJ has $1.4 billion in assets.

But that could be about to change. Precious metal prices – and mining stocks – may have fallen to what may be cyclical lows, and a rebound, while slow at first, may prove to be the beginning of a longer-term upward trend, according to CPM Group. Investors are likely to come back to the segment not only because metals and share prices are at attractive levels right now, but because there are still a lot of factors holding back real economic growth globally.

"We're telling people now we think 2014 is going to be the year where we see the prices bottom out, but don't necessarily run away to the upside," CPM's Managing Director Jeff Christian said in a recent interview with HardAssetsInvestor.

"But we expect that, by the end of the year, gold and silver and platinum and palladium will all be higher than they are now, and that gold equities also will be a lot stronger," he added.

In a broad sense, mining stocks are generally correlated to the price of the precious metals themselves, but they react more dramatically to fluctuations in price, both on the upside and on the downside. That explains why these ETFs have dropped far more dramatically than gold and silver spot prices did in 2013.

"Miners tend to be a high-beta play on the price of the metal itself," Andrew Chanin, CEO of PureFunds, told IndexUniverse. "When gold or silver goes up, miners go up more on a percentage basis."

But a slew of new merger-and-acquisition activity in the segment could point to a recovery, Chanin said. While many have tried to call for a bottom in mining stocks, Chanin pointed out that during the last run-up in prices, many CEOs made acquisitions of miners, and when the market turned around, these same CEOs were held liable for purchasing these assets at relatively high valuations. That's to say that these companies wouldn't be buying smaller miners unless they saw opportunity.

Junior miners, in particular, don't have predictable revenue streams, and can trade at deep discounts relative to larger mining companies. They primarily explore for precious metals rather than actually mine the metals.

"We've seen some overselling, and some miners are trading at ridiculous discounts," Chanin said. "Now, we're beginning to see M&A come back into the space."

"M&A tends to come in when the cycle is turning," he added. "They typically like to buy their mines at discounts, and we're seeing that activity coming back now. We're hoping this is a turning point for metals."

So far this year, only GDX has seen net asset outflows – of $223 million – while the other three ETFs have been net gainers. But it's worth noting that in 2013, GDX was hugely popular despite its dismal performance – the fund attracted more than $2.64 billion in net new assets last year.

"You don't want to put all your money into gold and silver," CPM's Christian said. "But if you look at it, the stock market is very high and very top-heavy; the bond market is suicidal to be long; and gold and silver, they've paid their dues."

"The prices are way off from their 2011 peaks," he added. "They probably represent good long-term buys for a portion of your portfolio."